Billions of dollars, backed by gold held at central banks, were recently loaned to commercial banks by the Bank for International Settlements (BIS). These loans, called gold swaps, were mainly made to European banks as part of an exchange for foreign currency, the majority of which was the United States dollar. These transactions have caused the status of the international banking system to come under further scrutiny.
The BIS, headquartered in Switzerland, is an international organization that fosters cooperation between central banks and other agencies. It also serves as a bank for many central banks, taking their deposits, while lending to corporations and commercial banks. This most recent transaction between the BIS and several European commercial banks involved gold to the tune of 349 metric tons, a value of approximately $14 billion. This is nearly triple the amount of gold that the BIS owns.
This gold swap involved BIS lending cash to financial institutions in exchange for gold. The financial institutions agreed to repay the loans and repurchase the gold at a later date. The gold has not entered the open market, so the market has been unaffected. The gold swaps will expire in less than 12 months, at which time the commercial banks involved will need to repay the loans and buy back the gold.
The BIS has not used gold swaps in recent years because there was always capital readily available. Some strategists are wondering why the commercial banks borrowed from the BIS rather than going to their central banks. The majority of the transactions took place in January, a time when worries began to surface that the sovereign-debt problem in Greece would spread throughout Europe.
If the commercial banks are unable to repay their loans, the BIS may choose to sell the gold on the open market in order to recoup its money. If these banks to repay the loans and buy back the gold, they may end up paying a higher price for the precious metal. Gold has risen in price 9.4 percent this year, so the banks may have to record losses on this, but they may instead have hedged the risk.
Source: Cui, Carolyn and Pleven, Liam. Commercial Banks Used Gold Swaps.
WSJ.com. 7 July 2010. Web. 8 July 2010.
Tags: Gold News, gold swaps